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Sunday, March 31, 2013

A vindication of Germany?

This article by Mats Persson will make a lot of people feel good, namely all those who have felt all along that the criticism of Germany's being the pariah of the EU was/is wrong. And, of course, excessively unfair, too.

Persson writes that 'there are three main factors driving Germany’s attempt to instil
this, and none of them is about seeking domination'. Many people in the South march on streets showing Angela Merkel with a Hitler-moustache proclaiming the Fourth Reich. If they spent any time living in Germany, they would know that this is a farce. The idea of Germans' desiring political domination of other countries is about as far fetched as the idea that Germans will ever become a spendthrift, sun-loving people who prefer idleness and/or fun over high productivity.

I am Austrian and Austrians have their own hang-up with German attitudes of superiority ever since Bismarck kicked Austria out of the German Union in 1871 on the grounds that 'Austrians were not fit to be Germans'. However, I have lived in Germany from 1974-80 and, more importantly, from 2003-10. If there is one generalization one can make about today's Germans, it is their abhorrence of all alleged 'German traits' which may have contributed to the result of the 1930s. In the extreme, this can even mean the rejection of social values which are important for nation building simply on the grounds that they had been used by their ancestors in the 1930s. Nationalism being one of them.

A former German President dared to say in public that 'he felt proud to be a German' and he was clobbered by the country's politically correct elite. Given its history, no German politician should ever say something like that. It almost seemed like Germans liked themselves better when they could hate themselves.

Another former German President was praised by the country's politically correct elite for having said, in an official speech, that 'the Islam is part of Germany'. No one dared to ask him what he thought Martin Luther, Johann Wolfgang von Goethe and/or Immanuel Kant might have said about that.

A friend of mine, a very traditional and conservative German of the older mold, keeps telling me that Germany has become a zombie society. A society which denies itself the pursuit of all those values which have made up German history. He attributes that to the 1968-generation-mindset which, he says, nowadays pervades all walks of German public life. And, he concludes, a society which does not hold on to its historical values (or rather: disavows them) will spell trouble in the longer term.

So much for Persson's argument that Germans are not seeking domination. I think he is absolutely correct!

Still, I do not agree at all that Germany can walk away free and clear of responsibility from today's financial, economic and political crisis in the Eurozone. On the contrary, Germany (together with France as a co-equal partner back in 2010) set in motion the process which may eventually lead to a breakup of the Eurozone and cause irreparable damage to the EU.

In 2010, Angela Merkel coined the phrase which may go down into history as one of the more expensive phrases ever coined by a politician: "If Greece fails, the Euro will fail and if the Euro fails, the EU will fail". Nicolas Sarkozy seconded that erroneous line of thinking by adding "Angela and I will make sure that the Euro stays in tact".

I am not saying that they intentionally lied but they certainly were less than truthful. Merkozy had one primary objective from the start: to do everything possible that their overexposed banks would not fail. And instead of being truthful about that, they disguised their strategy under the heading 'help for Greece'.

The destructive consequence of that policy was that two problems which should have been dealt with separately were now mingled: the saving of the banks on one hand and the help for Greece (and others) on the other.

Just follow this arithmetic: suppose that the total cost of 'saving the South' was/is 1.000 units by now. It is no secret that only about 200-300 of those units really went to the South while the remaining 700-800 units went to the banks. The shareholders of those banks are still untouched; they have received substantial dividends in the meantime and the bank managements substantial bonuses.

My argument from the beginning was/is that those 700-800 units should have gone directly to the banks instead of via the South. Not in the form of loans but, instead, in the form of equity. Existing shareholders would have been appropriately diluted, certain managements could have been replaced and the tax payers would have gotten something in return - equity in those banks.

To be sure: not with the intention of more permanent nationalization of banks but, instead, temporary and partial nationalization with the objective of repairing those banks and selling them to new owners afterwards. This would only have worked with bank supervisory and management boards free and clear of political influence.

In conclusion: Germany (and its co-equal partner France at the time) cannot be vindicated from responsibility. No alternative strategy could have avoided the painful but necessary economic adjustment in economies which lost their competitiveness. However, that lost competitiveness alone could never have led to the result which we are seeing today and which might endanger the worldwide financial system.

Germany (and France) embarked on policies aimed at saving banks by saving the Euro. Forcing uncompetitive economies to become competitive was seen as the best (and only!) instrument. In the end, they may fail on all three of these objectives.

6 comments:

1. Back in October 2010 at Deauville, Merkel and Sarkozy started to press for "Private Sector Involvement". They hit entrenched resistance (understandably) from the Banking Lobby and the ECB at the time. But it rapidly became a red-line for Merkel's CDU. "No PSI, No Bailout".

2. With the difference that Greek PSI was on sovereign debt, and Cyprus "Bail-in" was on Bank Debt, in both cases the emphasis was on those taking the speculative risk bearing the costs.

Certainly, the majority of bailout money for Greece then flows back to its creditors. And in the portuguese and irish cases, these creditors were in fact made whole, at taxpayer expense. A source of considerable bitterness in the countries concerned, obviously.

But this idea that germany wanted to save its banks looks wrong to me.

To me, the institution that has changed its position here is the ECB. Burning senior bondholders was completely taboo in 2010. In 2013, they talk about it openly.

Saving german banks? I don't think it's any sort of priority for Merkel. One of the big differences in germany is "Ordnungspolitik". A vague-sounding phrase about the regulatory and competitive framework, set by the government, in which economic activity takes place.

In the banking sector, Ordnungspolitik however isn't at all vague in its application. The retail banking sector is kept deliberately fragmented, and is in fact dominated by Savings Banks (Sparkassen) and Cooperative Banks (Raiffeisenbanken, Volksbanken) that are individually very small.

There is no "too big to fail" banking sector in germany! (Even if Deutsche Bank got into difficulties, they'd struggle to find much government support). And they don't want there to be one in the Eurozone. Therefore they apply the (unknown outside germany) principles of Ordnungspolitik to the crisis.

This is an aspect that I think most people miss.

France, now? That's a different matter. Very big universal banks, highly leveraged, several having huge exposure via greek subsidiaries in 2010. That Sarkozy wanted to save them seems highly likely.

There is a saying that no one on the outside should know what is behind the balance sheet of a bank; otherwise there might be trouble. I am adamant that this applies extremely so for German banks (I worked in banking in Germany from 2003-10).

After unification, a kind of gold rush developed and the West was lending enormous sums to the East. The East was going to be the future Eldorado. By the late 1990s, the house of cards in the East began to crumble and that had an impact on the West’s banks.

Until about 2004/05, the Landesbanken operated under a state guarantee. Thus, they could raise nearly unlimited funding at very low rates. And they did. There was allegedly a top-secret meeting among top officials (headed by the then Chancellor Schroeder) in 2003 on the question of what to do about the overexposed German banking sector once they lost the state guarantee. Nothing came out of it because the Central Banks kept flooding the world with liquidity and the problems could be covered up (or rather: postponed).

Before the state guarantee expired (stipulated by the EU), the Landesbanken loaded themselves with all the funding they could get. And, of course, they had to reinvest it.

Remember that Germany’s gigantic current account surplus means liquidity from offshore for the banking sector which liquidity the banking sector has to re-lend offshore. Thus, German banks were major players in just about every international financial bubble. The amount of sub-prime they owned (and still own!) was gigantic. Not to mention the sovereign bonds.

With that as a background, Germany entered the crisis of 2008. No surprise that Merkel and her Finance Minister felt it necessary to go on TV and to express an unlimited deposit guarantee for all savers at all banks.

Take Deutsche, which has a leverage of about 40:1 (compared with about 10:1 on the part of JP Morgan or Citibank). Deutsche has total assets of about 3.000 BUSD. Of that, only 450 BUSD are considered under Basel-2 as carrying risk, thus requiring capital backing. In other words, due to the Basel standards, which count sovereign and other AAA assets as risk free, Deutsche has 2.500 BUSD (that’s more than Germany’s annual GDP!!!) of assets with zero capital backing! Please think about the dimensions! Deutsche is, from a balance sheet perspective, a highly leveraged hedge fund. And given its size, if a bomb ever exploded there, it would have severe collateral damage on entire Germany!

I can’t judge to what extent things are better in the banking sectors of France or Britain but I certainly know how things are in the German banking sector.

Enter moral hazard and too-big-to-fail. Under Joseph Ackermann as CEO, Deutsche played this card brutally and with very strong nerves. Ackermann even had the nerve to say that ‘he would be ashamed if he had to accept bail-out money from the government’. Said the one who needed it the most! And on whom bail-out money should have been forced (like the US forced bail-out money on its major banks) just so that outside forces would get some serious influence on the malpractices of Deutsche.

Life isn’t fair and the likes of Deutsche seem to get away with it. Given all the trouble elsewhere in the Eurozone, the German banks appear beyond doubt (in the land of the blind, the one-eyed is king). But I guarantee you the following: should something ever happen which raises doubts about Germany’s financial stability, the banking sector would blow up in a hurry.

Merkel has simply been a genius in essentially covering up this situation with her posture that ‘everything is fine’. I guess the question is what else she should have done. Should she have blown up her own banking sector? Hardly. But the German government should/could have definitely steered a stronger course vis-à-vis its banking sector gone rogue. After all, the state always lasts a lot longer than any bank and, more often than not, banks survive because there is a state to bail them out when necessary.

Well, you've worked in german banking, and I haven't. But this is my state of knowledge: I'm aware of Deutsche's enormously high leverage. And I'm aware (being irish) that the decision to protect the senior bond-holders (including many german banks and insurance companies) there has cost the irish tax-payer dearly.

Deutsche (Ackermann particularly) played a very clever game. As the then head of the IIF, Ackermann had a lot of influence, and used it, on Greek PSI.

Background here: http://euobserver.com/eurozone/116770

In 2008, the private banks saw a *lot* of deposit capital flowing from them into the stadtssparkassen and cooperative banks. These have separate mutual guarantees (Haftungsverbund), and apparently a well-stocked depositor insurance scheme. That looks like rational behaviour by depositors to me.

And it was the stadtssparkassen and cooperatives that were lobbying hard about european banking union. Basically they don't want to get lumbered with the crazy leverages and bad debts of *either* Deutsche, or the other european commercial banks.

On the Landesbanken, yes, a complete disaster.

From the international perspective, I suppose Deutsche represent the "german banking system". Looked at from within Germany, they're more an outpost of that crazy "anglo-saxon" behaviour, and are distrusted. By the populace, and actually by the government too. From the popular point of view, it's the savings banks and cooperatives that represent the german retail banking system.

And it shows, too. There was an absolutely huge raid on deutsche by police and prosecutors a couple of months back, relating to a VAT Caroussel on carbon emission certificates. The british regulators had closed it down, and it promptly migrated to germany.

Yes, Deutsche represents the German banking system. There are probably quite a few people who think that, due to its name, it is the country's Central Bank. And no, it is inconceivable that Germany could ever stand by and see Deutsche go down the tubes. But that does not necessarily translate into a licence to go overboard. When the US government bailed-out the large banks, ALL of them had to take government funding. Some tried to object but didn't get away with it. Deutsche got away with it.

On one hand, I consider it as a major accomplishment that Ackermann could turn a second-tier bank into the world's power house. On the other hand, one has to be mindful of how he did it and what the consequences of that might be.

But let me not single out Deutsche too much. HVB was the bank which went berserk with the gold rush in the East. By the time reason returned, they were a basket case and had to be sold to Unicredit. Unicredit wanted no part of the junk Eastern real estate portfolio. What does one do? Right! One does some financial engineering.

The real bad part of HVB was spun off into a new bank, HypoRealEstate. Actually, it was a bad bank with only garbage. However, they had a management board, and above all a CEO who could tell beautiful 'stories' to investors. Before long, the shares of HRE were exploding and they even bought a bank in Ireland. Sure enough, when the HRE failed, it really failed good. If the government hadn't stood behind its obligation, that would have been some kind of a Lehman-effect on world markets.

HVB had so much junk in its portfolio that even after spinning off the bad bank, the presumed good bank still had so much junk it its portfolio that Unicredit had to write off quite a bit of the loan portfolio.

The Landesbanken I won't get in to because that simply defies description. One can only hope that no one blows the lid on them for some years to come.

So, I return to my point. Merkel had extremely good reasons to make sure that the German banks would not get into any bigger trouble. But there is no excuse for not taking banks, managements and shareholders to responsibility. No bonds would have had to be cut. Only some dilution of shareholders, curtailing of upper management bonuses and curtailing of dividends.

Wether Germany is actively seeking domination or not, is secondary. De facto, is dominating. Ready the headlines. Nobody cares if Barroso said something. Nobody is the central figure in any EU summit other than Germany. Nobody else can impose whether one country will be helped the irish way and another the cypriot way, other than Germany. You will also find that only in Germany, the "harsh" treatment and ridiculization of the "lazy" southerners, was popular enough to bring votes (you may have heard of a german MP of greek origin, Mr. Hatzimarkarkis. He has many times in the greek tv, admitted that both his party - the liberals- and the CDU, have used Greece as punching bag, because it was good for bringing them votes...)

It is a bit the nature of things. For further reference, you may want to read the passage from Thucydides' history of the peloponnesian war. In particular, the passage of the "negotiations" between Athens and Milos. Athens wanted Milos to join her side, Milos wanted to remain neutral. Athens, tried then the "offer you can't deny". Milos denied. It's the shortest, timeless, guide in international relations.

http://web.mit.edu/dimitrib/www/Milos_Photos/Milian_Dialogue.html

There are some very interesting and frank words coming from the Athenians there. There is also the hybris of the one with great power.

German politicians in particular, should read that passage. After not understanding what its relation with them is, read it again. And then also read their own history from Weimar repubblic up to the Marshall Plan.

ΒΤW, here are the predictions about the cypriot program (history that repeats itself).

http://i49.tinypic.com/34y1r9u.jpg

Translation:- EU Commission, as always, unrealistic, because they want to give less money and time. They know it's unrealistic, but, who cares, after all, Cypriots are harbouring gangster money, they deserve punishment.

- IMF more pessimistic, but can't impose the "truth" to Germany.

Result: the memorandum becomes a "compromise", over which the lives of people will be played like dice.

Officially it is called "EU solidarity".

At least, when the cypriot program will fail and a 2nd one will be needed, you will be able to say "well, in my blog someone had predicted it, i have heard it before!".